Cheap credit party ending

Your Money

THE FINANCIAL services industry has made it possible for millions of Americans to stop thinking, "I can't afford that."

Now Wall Street is beginning to wonder how many people really couldn't afford what they bought in recent years on incredibly cheap credit.

One percent mortgage loans, zero percent car loans, home-equity loans for more than your property is worth - all of this has been the cushy financial reality for U.S. consumers since 2003 or so.

While talk of a housing bubble has been incessant over the past year, only now are the money-changers on Wall Street beginning to worry about payback - that is, how much of the credit extended won't be paid back.

Home mortgage and equity credit line debt has swelled from $5 trillion in 2001 to $8 trillion now. And there's a lender behind every borrower.

Richard X. Bove, a banking industry analyst at the firm of Punk, Ziegel & Co. in New York, this month sent clients a research report with a chilling title: "This Powder Keg is Going to Blow."

Bove notes that the variations on adjustable-rate mortgages with low "teaser" rates have mushroomed, leading up to the newest twist: the so-called option ARM, in which the homebuyer chooses among several payment options, including paying only the loan interest each month. We're reliving the 1920s, Bove says. In those boom years, interest-only loans were standard, and lenders usually had the right to demand full payment on home loans after five years.

When the Great Depression arrived in the 1930s, and incomes and asset values dived, home repossessions soared.

Bove believes the lending industry has taken a step backward with option ARMs. "They are an outrage," he said. "The consumer simply does not understand what this loan is" in terms of the risks it poses - not the least of which is that the loan principal amount can rise instead of shrinking as it would under a full-payment loan.

What if home prices stop rising, or even decline? That could seal the fate of homebuyers who figured that, if their income couldn't keep pace with their payment obligations, they could simply sell their home at a profit and pay off what they owe.

But don't most people make their house payment, no matter what? Historically, they have.

For Wall Street, however, just the scent of a significant homeowner delinquency problem could be enough to spark a vicious reaction. Hedge funds and other trigger-finger investors won't wait to find out how bad things might get.

Worth noting is that financial services stocks make up the biggest single chunk of market value in the blue-chip Standard & Poor's 500 index, at nearly 20 percent.

The biggest threat of upheaval is in the mortgage-backed securities market itself.

That market, worth nearly $3 trillion, has provided much of the capital for the housing boom. Instead of holding on to the loans they make, many lenders package them and sell them to investors via mortgage-backed bonds.

If the mortgage-backed securities market were to seize up because of a pullback by nervous investors, the ripples would be felt across Wall Street, and around the globe.

The question is, will it take a full-blown financial crisis to get the lending industry, and those who supply it with capital, to admit the truth to people whose homeownership ambitions far exceed their means: "No, you really can't afford that."

Tom Petruno is a columnist for the Los Angeles Times, a Tribune Publishing newspaper.